Production-Based Asset Pricing and the Cross-section of Returns
Friday, Jan. 5, 2018 10:15 AM - 12:15 PM
- Chair: Stijn Van Nieuwerburgh, New York University
What Drives Anomaly Returns?
AbstractWhile average returns to anomaly long-short portfolios have been extensively studied, there is little work analyzing the drivers of realized anomaly returns. We establish novel facts about variation in these returns by decomposing them into cash flow and discount rate news. This decomposition offers insights into which theories best explain anomalies. Common patterns emerge across five well-known anomalies. The main source of anomaly return variation is news about cash flows. The cash flow and discount rate components of each anomaly's returns are strongly negatively correlated, and this negative correlation is driven by news about long-run cash flows. News about anomaly discount rates is slightly negatively correlated with news about market discount rates, and news about anomaly cash flows is uncorrelated with news about market cash flows. Our evidence is most consistent with theories in which investors overextrapolate news about firms' long-run cash flows and those in which firm risk increases following negative news about long-run cash flows.
Misvaluation of Investment Options
AbstractWe study whether investment options are correctly priced. We build and estimate a real options model of optimal investment in the presence of demand uncertainty. We then classify stocks into undervalued and overvalued based on the difference between observed and model-implied firm values. A long-short strategy that buys undervalued and shorts overvalued stocks generates annualized alphas between 10% and 17%. This relation is only present in subsamples of firms with high proportions of investment options. We interpret these findings as evidence of misvaluation of investment options, leading to mispricing in equity markets that is gradually corrected over time.
The Collateralizability Premium
AbstractThis paper studies the implications of credit market frictions for the cross-section of expected stock returns. A common prediction of macroeconomic theories of credit market frictions is that the tightness of financial constraints is countercyclical. As a result, capital that can be used as collateral to relax such constraints provides insurance against aggregate shocks and should command a lower risk compensation compared non-collateralizable assets. Based on a novel measure of asset collateralizability, we provide empirical evidence that supports the above prediction. A long-short portfolio constructed from firms with low and high asset collateralizability generates an average excess return of around 7.96% per year. We develop a general equilibrium model with heterogeneous firms and financial constraints to quantitatively account for the effect of collateralizability on the cross-section of expected returns.
- G1 - General Financial Markets